DON’T BORROW TROUBLE

A loan is good if it helps you create an appreciating asset

While you work hard towards financial goals, loans often come to your rescue and help cross important milestones, such as education, marriage, first car or buying a home. Rising competition among lenders and advancement in technology have made credit very accessible. However, taking loans without due diligence could make you default on repayment, land you in a debt trap and ruin your credit history. A poor credit history will ruin your chances of securing a loan in the future. Here’s how to make a wise borrowing decision:

GOOD VS BAD BORROWING

Be sure why you want to borrow. “Good borrowing is a way to accomplish your financial goals without putting a strain on your budget and the overall financial life cycle,” says Rishi Mehra, CEO, wishfin.com. “Bad borrowing could be a deal made at a higher interest rate. Even a loan taken to buy an expensive vehicle that isn’t your need would qualify as a bad borrowing.”

Buying for a sound cause will either help you create an asset or enhance your current/ future income. “Buying an appreciating asset, such as a home, can make a borrowing good, with income tax benefits,” adds Mehra. Buying property gives you an opportunity to earn in the form of rentals or as capital gain in the value of the property. An education loan can help you earn more in the future, so it is considered a good borrowing.

Avoid borrowing for depreciating assets. However, this may not hold true every time provided you generate a higher return by its usage, such as a vehicle purchased on loan but used to generate income that is higher than the aggregate of the cost of borrowing and depreciation value of the vehicle. Gadgets, home appliances or furniture. bought on loan would be categorised as bad borrowing. Other examples of bad borrowing would be for vacations, marriage, expensive phones and so on.

HOW MUCH LOAN SHOULD YOU AVAIL?

Your loan capacity is determined by your income, expenses and savings month-on-month. You also need to factor in future liabilities. Timmana Gouda D., CEO, whatsloan.com, says, “A person can service 20 per cent of the net income as EMI for such loans. Long-term secured loan and for asset creation can be up to 50 per cent of one’s net income, provided there is complete closure of the short-term loans (less than one year). Expecting an increase in incomes at 10 per cent per annum, one can borrow up to 30 years of home loans, but should plan to repay between 10-20 years, which is ideal for avoiding negative recovery of the principal amount.” As a rule, keep the total EMI within 50 per cent of the net income.

WHICH LOAN SHOULD YOU CLOSE FIRST?

“Try to close your unsecured loans first as they tend to be more expensive and can be a bigger drain on your pocket,” suggests Adhil Shetty, CEO, bankba-

zaar.com. “Unpaid credit card bills, for instance, should get the first preference. However, several personal loans have a prepayment penalty, and you need to calculate if prepaying the loan would be less expensive than paying interest on the loan.”

If you have credit card dues and are only paying the minimum amount due, your first priority should be to close this revolving credit as it carries high rates of interest at around 40 per cent. Follow it up by closing other costly loans, such as personal loans, auto loans, loans against gold, property and so on. If you are unable to repay a loan, try loan consolidation by taking a huge low-interest loan, such as home loan top-up, and use it to close the various small high-interest loans. In case of home loans, a bulk of the interest is paid in the first five years. If you can pre-pay a part of your loan in the first five years, your payable interest will come down significantly. However, a home loan helps save tax, especially for those in the higher income bracket. So decide to prepay the loan on the basis of your net saving.

NEVER BORROW FOR INVESTMENT OR SPECULATION

“One should avoid borrowing money for investment or speculation purposes,” advises Mehra. “You get fixed returns in the case of debt instruments, such as bonds, debentures and certificates of deposits.

These returns may not match the borrowing cost. On the other hand, equities are mostly volatile in nature. There’s no guarantee whether the investments made there would turn fruitful.” If the investment made through borrowed capital crashes, your objective of paying off the debt with the same would take a hit. Further, if you face financial contingencies, such as a job loss, the pressure would mount. If at all you want to invest, use your savings.